1. A five-year bond with a yield of 11% (compounded annually) pays an 8%

   coupon at the end of each year.

   1. (a) What is the bond’s price?

   2. (b) What is the bond’s duration?

   3. (c) Use the duration to calculate the effect on the bond’s price of a 0.2% de-

      crease in its yield.

   4. (d) Recalculate the bond’s price on the basis of a 10.8% per annum yield and

      verify that the result is in agreement with your answer to (c).

Suppose we wish to borrow $100 million for 90 days beginning next June, and that the quoted Eurodollar futures price is 95.

(a) What is the annualised 3-month LIBOR rate beginning next June implied by the future price today?

(b) Do you take long or short positions in the Eurodollar futures contract?

(c) Suppose on the settlement day, the futures price is 96. What is the profit/loss of your futures position?

Suppose firm T’s utility function is: U(X,Y) = X0.4Y0.6. The firm has a budget of $100, and the price of material Y is $20 and the price of X is $10. a) What is the optimal combination of inputs of X and Y for this firm? b) Suppose the price of Y and X are now $10 and $20, respectively. What effect will this have on the firm’s optimal input combination? c) Illustrate the answers to the preceding questions with the use of isoquant/isocost diagram.

Use the table and graph to answer three questions.

Using the table and graph answer the questions

a. What is the equilibrium price level?

b. What is the equilibrium output?

c. If the quantity of output demanded at ever price level increases by $2 trillion, what happens to equilibrium output and prices?

1. If the federal reserve pursues a contractionary monetary policy, output and the price level will change in which of the following ways in the short run?

A) Output – Increase; Price Level - Increase

B) Output - Increase; Price Level - No change

C) Output - Increase; Price Level - Decrease

D) Output - Decrease; Price Level - Decrease

E) Output - Decrease; Price Level - Increase

2. To counteract a recession, the Federal Reserve should

3. Suppose the required reserve ratio is 20 percent and a single bank with no excess reserves receives a $100 deposit from a new customer. The bank now has excess reserves equal to

4. The purchase of securities on the open market by the Federal Reserve will
      
A) increase the supply of money
      
B) increase the interest rate
      
C) increase the discount rate
      
D) decrease the number of Federal Reserve notes in circulation
      
E) decrease the reserve requirement

The data from Exhibit 3 is also in the Excel file income.xls on the course website. Use Excel, along with this file, to determine Mrs. Bella’s real income for the last fifteen years. Do this by first converting each price index from percent by dividing by 100. Then, divide gross income by your converted (adjusted) price index. Using Excel, find the mean, median, standard deviation, and variance of her past real income. Explain the meaning of these statistics. Can you use mean income to forecast future earnings? Take into account both statistical and non-statistical considerations.

A firm is expecting to receive $80M in 6 months and wishes to invest it for another 6 months. But the firm is worried about a potential decline in interest rates. Because of their flexibility, the firm decides to use call options on the 6-month T-bill. A call option on the 6-month T-bill with 6-month maturity exists with strike $95.8 (per $100 face value) and $0.34 premium. The current price of the 6-month T-bill is $96.92 per 100 face value.

Assume the firm thinks the initial cost of call options is too high. The firm considers alternatives to reduce the hedging costs. Discuss how the firms could reduce hedging costs through a collar. Assume there is a put option on the 6-month T-bill with 6-month maturity and a strike price of $94.00 (per $100 face value) and $0.20 premium. Draw the payoff diagram for the collar.